Can Bitcoins Buy Some Security?

February 2014 by: Alpha Tech

How the mighty have fallen! - fallen by $5.3 billion to be precise. This is the estimated plunge in value of all Bitcoin over the last 2 weeks after a spate of security scares and attacks led withdrawals of Bitcoin to be halted on some major exchanges around the world including Tokyo-based Mt. Gox.

The culprit was a flaw known as ‘transaction malleability’. Transaction malleability allowed rogue traders to mutate Bitcoin transactions and trick the software that ran Mt. Gox's digital wallet (a user’s individual record of his Bitcoin transactions that gives ownership of a Bitcoin balance so that he can send and receive Bitcoins) into believing that outgoing Bitcoin payments had failed even though they had actually gone through. The rogue trader would then demand that Bitcoins be resent.

In order to ensure that their software was secure and no funds were misappropriated, exchanges like Mt. Gox and Slovenia-based Bitstamp halted deposits and withdrawals on their systems – essentially freezing the exchanges, which sent investors and Bitcoin enthusiasts into a panic. And in an odd realization of their fears, online black market Silk Road 2.0 saw hackers use transaction malleability to attack the website’s escrow digital wallet and get away with $2.7 M of Bitcoin a couple of days later.  

Our Take Do these security concerns sound the death knell for Bitcoin? – Not quite yet we feel. Many agree that the interruption at Mt. Gox was due to the failing of the exchange’s own administrators rather than a fundamental flaw in Bitcoin’s protocol. After all, transaction malleability has been a known, albeit under-scrutinized, flaw since 2011. Other exchanges have since patched their systems against the problem – Bitstamp’s freeze only lasted a couple of hours and some exchanges had no service interruptions at all. Mt. Gox, on the other hand, is yet to restore Bitcoin withdrawals and last we checked its website had been deleted (red flags indeed!). And the price says it all: Bitcoins are trading at a substantial discount on Mt. Gox vs. competing exchanges (see graph).

Sure, Bitcoin infrastructure is still playing catch up to the security offered by the traditional banking system. Even governmental agencies have taken a ‘hands-off’ approach to regulating Bitcoin entities like Mt. Gox. But the irony is that for many Bitcoin enthusiasts, it was this relatively deregulated, open-source environment that drew them to the cryptocurrency world. So the question they have to ask themselves is:  are we willing to sacrifice some of the open, utopian ideals of cryptocurrencies to ensure real security and protection?